Sugar stocks have run up significantly triggered by higher sugar price outlook based on tighter supply side conditions. Earnings estimates for FY10 have been upgraded by about 75-200% depending upon the individual company’s profit-gearing to higher sugar prices, according to HSBC research.
Sugar prices, which rose from Rs 17.50 per kg to Rs 30 per kg in the last year, are expected to touch Rs. 35 per kg levels by Mar 2010. Supply side dynamics are expected to keep prices at these levels till 2011, according to a BoA- Merril Lynch research report on the sector. HSBC has upgraded FY11 earnings estimates by 40-140% based on this strong outlook.
This premise is based on an anticipated production shortfall of 30% likely in India this year, given the deficient monsoon. Cane cultivation area may not increase in the next year as demand for food grains will increase given the drought situation this year. Finally, a global shortage is possible because of under-production in Brazil this year, adds the BoA-MLreport.
India sweeter
Sugar inventories in India are at a 10 year low with stocks at levels of 1.7 months of consumption against a desired level of three months, according to HSBC research and India will need to import 6-7 metric tonnes in order to maintain this inventory level. Prices should, therefore, remain firm.
This expected shortfall also means that the government may increase its levy price, paid to sugar mills for the mandatory sugar supply for the public distribution system. The prices could be Rs 21 per kg for UP based mills (Bajaj, Balrampur and Triveni) and Rs 20 per kg for non –UP based mills (Shree Renuka in Maharashtra), according to HSBC, based on cane and conversion costs. The government had increased its levy quota for 2009-10 to 20%, from 10% earlier.
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The other positive news-flow was the announcement of a fair and remunerative price (F&RP) for cane, by the Central government. The interesting clause added to the Sugar Control Act was that if the cane price announced by the state governments (SAP- state advisory price) was over and above F&RP, the difference could be paid by state governments to the farmers to the extent of levy quota, or for the entire cost of cane. F&RP for FY10 has been announced at INR129.84/quintal for 9.5% sugar recovery in cane. This has brought down the SAP, according to HSBC. However, cane prices are expected to trend upwards in tandem with sugar prices and because of increasing competition between mills to increase capacity utilization.
Bottomline boost
The earnings upgrades follow expectations of higher margins as sugar price rise will be more than the rise in cane costs. Also, with current sugar prices substantially higher than levels when companies imported or bought sugar, margin are expected to expand by 650-750 bps, as per HSBC. Bajaj Hindustan, however, may see margins shrink by 160 bps but its earnings will benefit from a volume play, it adds.
FY11 earnings growth estimates are lower because of a bumper FY10 base effect but it is expected to still be higher than in the previous upcycle.
Sugar stocks have moved up in the last month and are trading close to multiples in the last down-cycle of FY07-08 in spite of having moved up substantially in the last year, according to HSBC. This time, the up-cycle in prices is accompanied by a healthier balance-sheet outlook for most sugar companies as most of the capex is completed with no further capex planned as of now. The strong earnings growth outlook (26-72% as per HSBC) should help towards almost debt-free balance-sheets by Fy2011, HSBC asserts. Interest costs are also expected to come down as debt reduces.
The net effect is a re-rating for sugar stocks.
The key risks are higher than expected production costs because of higher cane costs – due to under-production and stock loss in flood-hit areas and excessive losses in conversion of raw sugar to white sugar. Government reaction, in terms of levy quota hikes or lower levy prices as well as a possible cap on sugar prices if shortages become acute, is another worry.
Taking stock
Bajaj Hindustan has improved its balance-sheet quality by raising funds through a QIP and issuing promoter warrants recently. Its debt to equity ratio is down to1x from a peak of 4.7x in FY08. It is most sensitive to a hike in sugar prices and a 1% rise in sugar prices boosts EPS by 5.4% according to BoA-ML research. The stock closed at Rs 221.90 on 11 November, 09 (up 4.6% in the day) and trades at a valuation of 7.3x EV/ Ebitda estimates for FY10 by HSBC research. The multiple is higher than peers on account of its higher debt levels.
A 1% rise in sugar prices boosts EPS by 3% for Balrampur Chini. It also stands to gain from the change in the UP government’s change inpolicy allowing sugar mills to open power sales outside the state grid and allow sales to other states. The company is likely to distribute one-third of its profits as dividend, according to HSBC research, enhancing shareholder value Merger and acquisition rumours are strong triggers for the stock which recently soared and dipped as rumours of a promoter stake sale to Bajaj Hindustan started and then fizzled. The stock ended flat in day’s trading and closed at Rs 143.40 on 11 November, 09. It trades at a valuation of about 7.4x EV/ Ebitda estimates for FY10 by HSBC research.
Shree Renuka Sugars contracted raw sugar imports at a competitive rate, according to HSBC research, and stands to gain significantly on its operating margin front from higher refined sugar prices. A 1% rise in sugar prices boosts its EPS by 4%, according to BoA-ML. The company is expected to be debt-free by the end of FY10, according to HSBC, given the sharp rise in earnings. It currently enjoys the highest RoE and RoIC of 41% among peers. The news flow of its Brazilian acquisition is a potential trigger for the stock as it achieves backward integration assuring it of raw sugar supply as it is the country’s largest raw sugar importer. The stock closed at Rs 218.95 on 11 November, 09 and trades at a valuation of 5.3x EV/ Ebitda estimates for FY10 by HSBC research.
Triveni Engineering is the country’s third largest sugar manufacturer and has historically traded at a premium to UP based peers because of its diversified business model where about 40% of revenues come from its Engineering segment. The higher return ratios mainly because of its engineering segment and less geared balance sheet are key positives for the company. A 1% rise in sugar prices boosts its EPS by 4%, according to BoA-ML. The stock closed at Rs 107.30 on 11 November, 09. It and trades at a valuation of about 5.5x EV/ Ebitda estimates for FY10 by HSBC research.